The surprising bull: Thomas Piketty on Wall Street
Right after he got the Nobel Prize in economics last fall, and just before he took off for Sweden to accept it, Bob Shiller spoke to us about a number of things, including his view of the stock market and its current apparently lofty level.
Bob is committed to the old John Kenneth Galbraith truism: that there are two kinds of economists — those who don’t know the future and those who don’t know they don’t know. He defines himself as among the former. I’m with him.
But that doesn’t mean he is devoid of opinions. When an economic statistic veers sharply from historical trend, Bob becomes suspicious. The overall market is now selling at 25.48 times the earnings of the companies that comprise it — earnings averaged over the previous decade to account for cyclical ups and down in earnings. This is Shiller’s so-called CAPE ratio: cyclically adjusted price earnings ratio, which he updates daily.
As you can see by eyeballing the chart, in terms of the profits of its companies, the stock market as a whole roughly averages 15 or 16 times adjusted earnings and has only been more expensive than it is today three times in its history: the late 1920s, the late 1990s and the early Aughts (2004 or so to 2008). No wonder Shiller thought the market seemed bubbly when we last we spoke:
Paul Solman: Is there a stock market bubble?
Bob Shiller: I think the stock market bubble is related to the very low interest rates. That’s because investors don’t see the alternatives in the debt market as attractive, so they pile into the stock market and bid it up.
But I don’t think that’s the whole thing. I think the psychology of the market has so many dimensions to it. Back in 2009, when the market bottomed out, people were afraid of a 1929 style crash. I know because I was I was doing a questionnaire, and I asked: Are you worried about 1929 or 1987 again? And I got record high numbers of people saying that. It’s the mindset that we had just a few years ago that people forget now. You think now: That was the bottom of the market. [Back then,] they didn’t think it was the bottom. They thought it could go a lot further down. Then, however, the market turned around and started going up.
That brought on people thinking: Hey, maybe I should get into this. And so more and more people desired to get in at that price and that caused the price to go up. And it’s been a feedback loop for going on four years now. That’s a long time, and that is not just the doings of the Fed. People imagine that the Fed is more powerful than it really is.
Paul Solman: Are we experiencing, to use your phrase from 1996, I think, “irrational exuberance” in the stock market again?
Bob Shiller: Well, some people are. I have my own confidence indexes which I’ve been computing for years now. I don’t think that we are back to where we were in the late 1990s, when we had the most dramatic bubble – the so-called tech bubble. I think it has bubble elements to it, because people see the market going up and they’re regretting the fact that they didn’t buy in several years ago, and they are tempted back into it.
But it isn’t the really strong bubble that we saw before because there are so many clouds – there are so many issues on people’s minds that it doesn’t look like the chance of a lifetime now.
Paul Solman: But the index to which you refer, the cyclically adjusted price earnings ratio, that’s at about 25 at the moment. It peaked at 45 back in 2000. In 1929, it was about 35, but historically the average is somewhere like 15, 16? So 25 to 15 is overvalued by 60 percent.
Bob Shiller: It can keep going up. It’s not a clear signal yet. Well, 25… it could go up to 35, easily.
Paul Solman: And then you’d have left a lot of money on the table by not having bought at 25.
Bob Shiller: That’s the problem. Yeah, it’s time to be worried, but it’s not necessarily time to bail out.
Paul Solman: I remember when we drove around in a go kart about 10 years ago. [Wharton professor] Jeremy Siegel, your buddy, was lapping us around the track. I was in the middle and you were putting on the brake because you’re such a cautious person.
Bob Shiller: A cautious person, yeah. But I have money in the stock market. I have it in low-CAPE sectors. You know, you don’t have to put it into the whole market.
Paul Solman: So you mean sectors in which the cyclically adjusted price earnings ratio — that is, counting the earnings of the last 10 years — on average, is not as high as the market as a whole.
Bob Shiller: Well, not as high as it was relative to its own historical performance. You have to put your money somewhere. You can’t hide it under a blanket. You can put it at zero interest rate and that’s OK now. But I think that it’s not so risk-taking to put some of it into the stock market, especially in value investments in the stock market.
Paul Solman: What percentage of your asset allocation is in the stock market, roughly?
Bob Shiller: I would say it’s about 50 percent, but I don’t have the exact number. And I don’t think it necessarily means that I’m a model for everyone. I’m someone who is older, and young people can take greater risks. I’m not advising them to, but it’s natural that they might.
That was Bob Shiller in the fall. Today, his CAPE ratio is still around 25 and he’s still in the market, as he told NPR’s Tom Ashbrook and his “On Point” audience last week.
Earlier this year on Making Sen$e, British economist Andrew Smithers expressed concerns about an overvalued market, and just Wednesday, Terry Burnham reiterated his prediction that recent market highs aren’t likely to last. We’ll see the Dow at 5,000 sooner than we’ll see it at 20,000, he says.
Thomas Piketty, by contrast, has a rather different point of view. To him, capital is king and, if current trends continue unabated, is likely to command an even greater return in the future. Here’s how our short exchange went:
Paul Solman: Is the stock market now fairly or maybe even under-valued? Because if you’re right and the return on capital is going to continue to get greater, why, then, stocks are going to be worth more in the future because they represent a claim on capital, right?
Thomas Piketty: Yeah, you know returns will keep moving all over the place, but in the long run, what we see in the stock market are returns on the order of 6 or 7 percent, so these have to be much bigger than the growth rate — except in China, when you have a 10 percent growth rate. But in normal countries, where you have a growth rate of 1 or 2 or 3 percent, long-run returns are definitely higher than the growth rate.
Paul Solman: So you’re not surprised at the American stock market and what it’s doing?
Thomas Piketty: This is the long-run average and the past experience is our best guide for the future.
One could, then, read the Piketty projection either way. Yes, if returns to capital keep rising, stock valuations might keep going up. On the other hand, if past experience is our best guide… well, in the end, it’s your call. What do we — any of us — know?
Watch my complete interview with Piketty about his inequality theory and the success of his book “Capital in the Twenty-First Century”: